Why You Shouldn't Invest in American Stocks

By Tim Hanson and Brian Richards
November 5, 2010

Before you get any ideas, let it be known that we love the NCAA tournament, Oreo cookies, and Saving Private Ryan. But when flipping through an issue of Fortune, an astoundingly hammy ad made me (Brian) stop cold.

In big, bold letters, it read: "When you invest in America, you're really just investing in yourself."

The ad is for the SPDR Dow Jones Industrial Average ETF (NYSE: DIA), and we have nothing against that exchange-traded fund per se -- it has low expenses and does what it says it will, tracking the 30 stocks in the Dow.

The ad, though, sells an investment in a way that undermines the investor -- by pandering to patriotic emotions. Here's more of the text:

There's an unspoken agreement in America that each generation should leave this country in better shape than they found it. Maybe that's why the U.S. economy has been growing since the Industrial Revolution. Everyone tries to do their part. If you believe this covenant still exists today, consider the SPDR Dow Jones Industrial Average ETF. [emphasis ours]
A touch melodramatic, eh?

We'll cut straight to why you shouldn't invest in American stocks: Because you are patriotic and sentimental about America. Kudos if you are those things -- just don't invest for those reasons.

Losing money is not patriotic
Consider, for example, Ford (NYSE: F) and Toyota (NYSE: TM). Are you more patriotic if you owned Ford over the past decade? No, you're just poorer (though both have lost money for investors, given how difficult it is to compete in the cyclical auto industry).

And while you might have thought it would help Ford out to purchase its stock when it was imploding in 2009, the fact is, when you buy a stock in the stock market, that money does not go to the company. Instead, it goes to a person who bought the stock from some other person.

So rather than bail out Ford, you were actually bailing out the person who bought Ford before you. That said, Ford has turned out to be a great investment since 2009, thanks to its return to profitability under Alan Mulally -- for reasons that have nothing to with patriotism.

The point is, companies only raise money during offerings. If you're buying or selling stock on the open market during a regular trading day, it generally will have no effect on the operations of the underlying company.

And even when it comes to offerings, you shouldn't buy shares of a company because you think it needs help, or because it might be patriotic to do so -- as the marketing surrounding the inevitable GM IPO will almost certainly imply. Most companies, when push comes to shove, won't return that thoughtfulness to their shareholders.

There's a larger lesson here
Patriotism, however, is only one of the ways that you might get suckered into making a poor investment decision. Others include buying into a rising stock for fear of missing out on gains (as so many did during the tech bubble), or selling a stock that's dropping solely because you're afraid it might go lower. Or as The Wall Street Journal explained recently:

Everyone develops attachments that can be irrational sometimes, whether to a house, a car, even a person. People can also get overly attached to a particular investment, believing it will reach -- or return to -- a certain price. Or they may place too much importance on one piece of information when making an investment decision. These are examples of anchoring bias, which causes the investor to hold on to the asset for longer than they should.

So there's a large lesson here, and it's this: An emotional investment is bad investment.

Don't believe us? Thankfully, there's now an entire field -- behavioral finance -- devoted to studying the ways in which our investing hearts get the best of our investing minds (actually most emotion happens in the brain as well, but stay with us).

Rather than rehash it all, we'll quote a Stanford study sums it up unequivocally: "Emotions can get in the way of making prudent financial decisions." We also recommend you read the fabulous Jason Zweig book, Your Money & Your Brain.

But back to America
Frankly, we think it's irresponsible for an ad agency to pull your patriotic heartstrings to make you want to buy an investment product that tracks the Dow 30. Not only is it intellectually strange -- assuming your dollars do go to support the business you buy, wouldn't it be more patriotic to buy shares of a collection of American small business, rather than 30 massive multinationals? -- it's just flat-out inane. A sense of civic duty is no reason to buy a stock or ETF, period.

Yet none other than investing icon Warren Buffett went to the exact same well when, during the peak of the financial crisis, he published his now-famous New York Times op/ed titled "Buy American. I Am."

To be fair, editorial page editors often pick the titles of editorial page editorials, so Buffett may not have been responsible for that slightly over-the-top headline (though who are we to criticize for an over-the-top headline?). Furthermore, the headline isn't even consistent with what Buffett's actually been buying at his investment vehicle, Berkshire Hathaway.

The holding company now owns stakes in China's BYD, the U.K.'s GlaxoSmithKline (NYSE: GSK), Switzerland's Nestle, and France's -- yes, France's -- Sanofi-Aventis (NYSE: SNY). What's more, Berkshire owns sizable stakes in ostensibly American companies such as Coca-Cola (NYSE: KO) and Wal-Mart (NYSE: WMT) that have investment and growth abroad -- key parts of their business strategies going forward.

No, Buffett is not a hypocrite
This is all very smart -- both for the companies and for Buffett. Emerging markets are growing faster than the U.S. and have less ominous debt profiles. The dollar is weakening relative to those currencies. It makes sense to have a healthy dose of foreign exposure today! In fact, we'll go so far as to predict that if you buy foreign stocks, you'll earn better investment returns and end up paying more in capital gains taxes -- money that will actually go to prop up America (if that's the sort of thing you're looking to do).

All told, the takeaway from Buffett's editorial was not "Buy American," but rather found farther down in the copy: "A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors." Sometimes, that means Buy American, and other times it means Buy Abroad. But all the time, it means that you should make smart, unemotional decisions with your investment capital.



http://www.fool.com/investing/general/2010/11/05/why-you-shouldnt-invest-in-american-stocks.aspx